Question

a. (4-4a) Who includes income from personal services in the gross income? b. (4-4b-dividends) To whom are dividends taxed? (e.g., when a taxpayer sells stock after dividend has been declared but before the record date) How is it different for a sale and a gift? (4-5a) How are gains and losses from property transactions recognized for tax purposes? a. How do you calculate realized gain or loss? How are they recognized? b. How are the net capital gain/loss taxed for individuals? For C corporations? (You don't have to know the capital gain/loss netting process for this exam.) (4-5b) What is the tax treatment of interest on state and local government obligations? (Remember that the exempt status applies solely to state and local government bonds.) What is the tax treatment of interest on U.S. government obligations?

Answer 1

a. (4-4a).

For households and individuals, gross income refers to the sum of all incomings/forms of earnings like wages, salaries, profits, interest payments, rents, before any deductions or taxes. Income from personal services must be included in the gross income of the person who performs the services.

It is opposed to net income, defined as gross income net off taxes and other deductions (e.g., mandatory pension contributions).

b. (4-4b).

Dividends are taxed in the hands of the taxpayer. Dividend tax rates paid on ordinary dividends are the same as the regular federal income tax rates (Any dividend that is paid out from a common or preferred stock is an ordinary dividend unless otherwise stated). Qualified dividends, on the other hand, are taxed at the capital gains rates, which are lower.

Dividend on stock sold after the declaration date, but before the record date, is taxable to the purchaser.

If the stock has been gifted, after the declaration date, but before the record date, dividend is taxable to the donor of the stock.

The basic principle adopted is that a taxpayer cannot escape his tax liability merely by assigning his right to receive income to another party. But he can shift the liability, if he assigns income producing asset, rather than the income itself.

(4-5a).a.

Most of the things owned and used for personal or investment purposes is a capital asset. Eg. house, jewellery and stocks or bonds held as investments. When capital asset is sold, the difference between the adjusted basis in the asset and the amount realized from the sale is a capital gain or a capital loss. Generally, an asset's basis is the cost to the owner. Capital gain is realized if sale consideration for the asset for more than the adjusted basis (cost to owner) and Capital loss is realized if the asset is sold for less than your adjusted basis.  

Capital gain/losses are classified into short term and long term basis the period of holding of asset. If the asset is held for more than a year before disposing,capital gain/loss is Long term. If the capital asset is held for a year or less, the same shall be classified as short term capital gain/loss.

b.  Long term capital gain tax rate will be lower than the short-term tax rate. The IRS collects ordinary income tax rate for short-term capital gains.

The tax rate on most net capital gain is no higher than 15% for most individuals. Some or all net capital gain may be taxed at 0% if your taxable income is less than particular threshold limit. However, a net capital gain tax rate of 20% applies to the extent that your taxable income exceeds the thresholds set for the 15% capital gain rate. Further, there are a few other exceptions where capital gains may be taxed at rates greater than 20%.

Unlike individuals, who enjoy preferential tax treatment for long-term capital gains, C corporations do not get such preferential tax treatment. Capital gains are simply added to the corporation's ordinary income along with other income items and taxed at the corporate tax rates. Although corporations do not enjoy preferential tax treatment for capital gains, they must continue to classify capital gains / losses as short-term and long-term.

(4-5b).

Interest from US obligations such as US Treasury bills, notes and bonds issued by any agency is subject to federal income tax.  Treasury bills generally are short-term issues with maturities not exceeding 1 year issued at a discount. Interest on a Treasury bill is the difference between the discounted price originally paid and the face value received at maturity.

Similarly,  zero-coupon investors must report pro-rated portion of interest each year, as income, even though interest has not been paid out.  They are taxed as interest, just like any other original issue discount bond.

Municipal bonds are favored by high-income investors looking to reduce their taxable income. The interest from these bonds is tax free at the federal, state and local levels, as long as investors reside in the same state or municipality as the issuers. However, municipal bonds bought in the secondary market and sold later, may be taxed at ordinary long- or short-term capital gains rates.